The Italian government, which had vowed to balance the budget in 2013, now expects a shortfall of 0.5 percent of gross domestic product next year, the Cabinet said in an e-mailed statement after meeting in Rome Wednesday to revise its three-year economic plan. The deficit of 0.1 percent previously estimated for 2013 won’t be reached until 2014.

“While much progress has been achieved, there’s still a long way to go” to reorder public finances, according to the statement. The new plan forecasts the economy will shrink 1.2 percent this year, more than double the 0.5 percent contraction predicted in December, before returning to growth of 0.5 percent in 2013, the Cabinet said.

“The financial crisis is exacting a huge price on Italian families and young people,” Monti said at a press conference after the Cabinet meeting.

Italy’s backpedalling on its fiscal objectives raises fresh concerns over Europe’s recipe of enacting austerity measures in the face of a recession. Monti pushed through a 20 billion-euro ($26 billion) austerity plan in December to shield the economy from the debt crisis, though the effort helped tip Italy into its fourth slump since 2001. Spain, which has passed about 40 billion euros of spending cuts and tax rises since December, is mired in a deepening contraction amid the highest jobless rate in Europe.

Yields Rise

Bond yields for both countries, which had fallen after an injection of 1 trillion euros into the banking system by the European Central Bank, have surged since Prime Minister Mariano Rajoy announced on March 2 that Spain wouldn’t meet its deficit goal this year. The yield on Italy’s benchmark 10-year bond erased gains after Italy announced its economic plan, rising 10 basis points to 5.53 percent at 3:08 p.m. Rome time, compared with 4.9 percent on March 2.

Italy’s economy probably shrank for a third straight quarter in the three months through March, the Bank of Italy said yesterday, complicating efforts to reduce debt. The government’s economic plan today forecasts the euro-region’s second biggest debt burden will rise to 120.3 percent of GDP this year from 119 percent in 2011, figures that don’t include contributions to Greece’s bailout and Europe’s rescue funds.

Italy’s debt including those contributions will increase to 123.4 percent this year before falling to 121.5 percent in 2013, Deputy Finance Minister Vittorio Grilli said at the press conference today.

‘Worrying’ Debt

Italy’s “postponement of the deficit-target goal, coupled with the projected increase of debt in the next few years, which is even more worrying, are likely to undermine markets’ confidence in the government’s ability to keep public finances under control,” Gianluca Ziglio, an interest-rate strategist at UBS in London, said by phone.

Rajoy fueled speculation that Spain would follow Greece, Ireland Portugal into a bailout when he told European Union allies on March 2 that his government couldn’t meet its deficit goal for this year. Spain settled on a new target of 5.3 percent of GDP, up from the 4.4 previously pledged.

The move eroded investor confidence in the bonds of so- called peripheral nations. Spain’s bonds have fared worse than Italian debt, with its 10-year yields rising about 1 percentage point since March 2 to 5.88 percent at 3:10 p.m. Madrid time.

IMF Forecasts

The International Monetary Fund yesterday signaled that even Italy’s new forecasts are overly optimistic. The IMF predicted the economy will shrink 1.9 percent this year and 0.3 percent in 2013. Italy’s deficit will narrow to 1.5 percent in 2013, three times the government’s forecast. The IMF’s GDP forecast compares with a drop of 1.3 percent this year estimated by the European Commission on Feb. 23. The commission releases new deficit forecasts next week.

“We are a short-term government called on to make enduring changes,” Monti said today, calling for an overhaul of Italy’s political system to match his economic reforms. “What we are doing is only the beginning of an operation that will last for many years, but that doesn’t mean there will be many years without growth.”

Monti is facing rising discontent as Italians chaff under the effects of the austerity package, with brought higher taxes and record gasoline prices that have reached almost 2 euros a liter, or $10.50 a gallon.

Popularity Dip

The premier’s popularity fell further after his Cabinet approved last month a key bill to overhaul the labor market, prompting a call for a general strike by Italy’s biggest union and strong criticism from the Democratic Party. The protests forced Monti’s unelected government to water down some measures easing firing rules to secure support of his political allies in Parliament. Employers have also complained that measures don’t go far enough to increase flexibility.

“The fact that budget targets are now a touch more realistic should be viewed in a positive light, given the risk of a recessionary spiral caused by continuing fiscal tightening and a deepening recession,” Riccardo Barbieri, chief European economist at Mizuho International Plc in London, said in a note today. “However, there’s no doubt in our mind that the dilution of critical reforms has dented optimism about Italy’s turnaround potential.”